Predictions Are Hard, Especially About the Future

One thing I never get about trying to score the quality of various prognosticators’ economic predictions is that future macroeconomic trends are not independent of people’s opinions about future macroeconomic trends. If Alan Greenspan had spent 1999–2001 worried something other than what he was worried about, he presumably would have done different things with the interest rates, in which case different things would have happened.

Which isn’t to say that everyone who’s made bad predictions should be excused. Rather, it seems to me that the issue is that nobody should be making firm predictions of this sort. Are we in for a long and painful recession? Well, it depends on what we do. Rather than say that we are or aren’t in for such a thing, much better to talk about under what circumstances we’ll face such a recession. Under current circumstances, the risk seems to me to be that, on the one hand, we’ll implement a neo-Hooverite austerity budget while, on the other hand, insolvent banks take advantage of the fact that Hank Paulson took the taxpayer out of the management loop in the banks we now co-own, to make foolish gambles that have small, bad odds of big payoffs.

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Basically, with the taxpayer owning “preferred” shares in the banks, a bank with a very low value is worth nothing at all to its ordinary shareholders and its management. If it sinks even deeper into the mire, that’s no loss to current shareholders and managers. And if it becomes worth slightly more, that’s no gain to current shareholders and managers. But if it becomes worth much more that’s a lot of gain to current shareholders and managers. So bank managers may make a series of risky bets that, since Paulson got us non-voting shares, we can’t stop them from making. This could end up with the banks even deeper under water and with the whole financial landscape plagued by zombie banks that prevent recovery. If those two things happen, we could be in for a very long and painful series of economic problems.

But the point of raising these worries isn’t to predict that they’ll happen. Rather, the point is to urge people to make sure they don’t happen.